Could European rearmament plans unlock an infrastructure supercycle?

The outbreak of conventional warfare in Ukraine highlighted the challenge Europe faces as its current manufacturing capacity significantly lags the voracious consumption rates of modern combat.

Furthermore, with overlapping crises and the potential for multiple points of global instability, supply chains can no longer be relied upon to the same extent.

In the last five years, the US supplied 64% of the military equipment purchased by European NATO nations, up from 52% in the previous period, highlighting a dangerous and growing reliance on imports.

However, it is impossible to revive the European industrials sector and enact a credible national defence without secure energy and rapidly scalable manufacturing.

Thus, Europe’s planned spending wave could create substantial commercial opportunities far beyond pure-play defence contractors. European governments are increasingly shifting their procurement strategies to incorporate the infrastructure necessary to reshore a far larger proportion of the military supply chain, aiming to be more resilient to geopolitical shocks.

It has been estimated that two thirds of the European mid and large cap industrial sector is expected to benefit directly from this spending spree.

Yet despite this tailwind, institutional investors have historically been hesitant to engage with defence companies due to their perceived incompatibility with ESG and sustainability mandates.

Until recently, defence companies and even associated industrials were rated poorly, and categorised as containing high ESG risk, rendering them ineligible for inclusion in many institutional mandates. However, the conflict in Ukraine forced a wholesale re-evaluation of these exclusionary policies, with both the Financial Conduct Authority and the European Commission clarifying that their sustainability rules do not prohibit investment in defence companies.

This has already translated into 43% of European ESG equity funds now having exposure to aerospace and defence, not far shy of the 56% of non-ESG equivalents invested in the sector. Although, of course, not all investors will be comfortable with defence investments, and there are still a number of ESG equity funds that avoid this sector altogether.

In public markets, these defence tailwinds have already spread to those companies considered best positioned to benefit from Europe’s forthcoming supply chain expansion.

One such example is Investor AB, the Swedish listed investment company managed by the Wallenberg family, which is included in the Wealth Club Portfolio Service. It maintains a concentrated portfolio of both listed and private companies operating predominantly within the healthcare and industrial sectors. Several of its underlying companies have benefitted from the wider rearmament megatrend, anchored by a strategic involvement with Saab, the Swedish aerospace and defence manufacturer.

Furthermore, the European Commission’s planned fiscal package also includes a proposal to raise up to €150 billion via capital markets.

These raised funds will take the form of structured long-term loans backed by the EU, designed to finance critical high-technology areas such as missile defence, drones and cybersecurity.

This could trigger a massive requirement for secondary financing within the supply chain, presenting a potential opportunity for investors to gain exposure to companies on the receiving end of multi-year national defence contracts.

Therefore, as Europe’s historic infrastructure and defence transformation accelerates, private markets could be well placed to offer investors an opportunity for diversified exposure to the very root of this buildout.

Historically, these private market vehicles would have been primarily limited to institutions, prohibiting individual investors from gaining exposure beyond the topline public beneficiaries of Europe’s defence spending wave. However, the proliferation of semi-liquid funds from several of the largest Private Markets managers has provided a new vehicle for eligible investors to access this market with far lower minimum investments.

Through the Private Markets service from Wealth Club, investors can access relevant funds across the private market spectrum, including Private Equity, Credit, and Infrastructure vehicles, each reviewed by our research team.

However, these assets are deemed high-risk investments, so it is important to appreciate that they are more vulnerable to pricing uncertainty than publicly traded alternatives.

Furthermore, any investment should be treated as a long-term commitment. It may take many years to generate a return, if any, which may not be easily realised. Eligible investors should therefore only invest funds that they do not expect to need for at least five to ten years.